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Where do you place the Stop Loss?

Using Stop to Protect Profits
Written by Andy
  1. Where do you place the stop loss? Learning to accept plenty of small losses allows you to protect your capital for the winning trades; although this is only possible with a bit of forward thinking. A simple way to work this out is to use a 2% capital rule (absolute maximum 5%) which means that should a trade be stopped out it will not cost you more than 2% of your total trading capital. For instance, if you have £20,000 in your CFD trading account you should not risk more than £400 on a single trade. Thus if you wanted to buy the Dow at £2 a point your stop should be no more than 200 points away from the entry level.
  2. Trade in a size that allows you to ‘comfortably’ put the stop sufficiently away to avoid being triggered prematurely by the normal market movements. This gives your trade more time to turn into profit.
  3. In practice, assuming you’re not paying for the guaranteed stop loss, the price can gap through your stop loss level meaning you owe more than you expected. Also as I have hinted above, there’s the old psychology of it. As the price approaches your stop level, you’re CONVINCED it’s a fake, that the market WILL turn around, so you move your stop back, it approaches again, so you move it back further. Before you know it, you’re looking at the mother of all losses and IG is calling you regarding depositing more money.
  4. Most traders when they are just starting out will attach a stop loss to every position, so they will always know the maximum amount they’re risking. And one of the most important things about trading is knowing when to get out. It is not about getting it right or wrong, but how much you gain when you’re right and how much you lose when you’re wrong. The key is to detach yourself from the shares you are trading. Take anything they do after you sell for learning lessons and add them to your investment experience, but don’t play the emotional what if, should have, could have. Keep in mind that you moved your funds to something else and that something else is also changing.
  5. Even worse than hanging on to losing positions is a trader who averages down i.e. by buying more shares in the same company as the price falls. Never average down, just resist the temptation to add to losing positions! While averaging down lowers the average cost of the investment it also increases the exposure to one single share. When this goes wrong it can do so with disastrous consequences. Unless your pockets are very deep you must learn to cut losses quickly – the daily retreats of a losing position can be debilitating.
  6. So again, do not average down. There is no reason to add to a losing position. If you’re wrong about the trade you entered, your stops will take you out. If you lost money in a stock, make it back in some other stock, don’t try to dollar-cost-average a trade to get out at break even.
  7. Learn from your mistakes. Traders who start with a winning streak of trades may become quite complacent whereas a loss provide you with an opportunity to reflect on your trades and learn to be a better trader.
  8. Finally, recall that the markets can remain irrational for longer than you can remain solvent no matter what you think, believe, hope or pray! The volatility of the equity markets can create some huge movements in share prices. Never risk money you cannot afford to lose.

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